inflation and changes in expectations about inflation. 1b. Increases in monetary growth rates lead to persistent inflation and changes in expectations about inflation. 2a. Increases in relative demand of domestic products lead to a real appreciation. 2b. Increases in relative supply of domestic products lead to a real depreciation. 16-48 14/05/2013
13 •What are the effects on the nominal exchange rate?
14 Real Interest Rates • Real interest rates are inflation ‐ adjusted interest rates: r e = R – e where e represents the expected inflation rate and R represents a measure of nominal interest rates. • Real interest rates are measured in terms of real output: – the quantity of goods and services that savers can purchase when their assets pay interest – the quantity of goods and services that borrowers cannot purchase when they must pay interest on their loans • What are the predicted differences in real interest rates across countries? 16-53 14/05/2013 Real Interest Rates (cont.) • Real interest rate differentials are derived from r e US – r e EU = ( R $ – e US ) – ( R € – e EU ) R $ – R € = ( q e US/EU – q US/EU )/ q US/EU + ( e US – e EU ) r e US – r e EU = ( q e US/EU – q US/EU )/ q US/EU • The last equation is called real interest parity . – It says that differences in real interest rates (in terms of goods and services that are earned or forgone when lending or borrowing) between countries are equal to the expected change in the value/price/cost of goods and services between countries.
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